Why is the Federal Reserve the Only Game in Town Trying to do Something About Unemployment?

December 22nd, 2012 at 4:35 pm

Tim Noah has a nice piece up at TNR that tackles a question I recently posed here: Why are the members of the Federal Reserve—an unelected body, mind you—the only policy makers in town aggressively targeting the unemployment rate?

Tim’s answer is twofold. First, why is Congress less interested? It’s the toxic combination of wealth concentration and money in politics:

..as top earners’ shares of the nation’s income grew, so did their shares of politicians’ attention. And since involuntary unemployment is not something wealthy people typically fear, Congress gave the issue scant attention.

Second, why is the Fed more interested? Here, Tim suggests that the long and deep output gap, in tandem with some personnel who are just more sensitive to the human costs of such gaps, forced their hand on the unemployment (versus inflation) side of their mandate:

Not having given unemployment much thought before 2008, the Fed took several post-crash years to figure out that, with Congress abandoning the field, it could no longer keep thinking like a mere bank. It had to take seriously, for the first time, both parts of its dual mandate. “Imagine that inflation was running at five percent against our inflation objective of two,” Chicago Fed President Charles Evans said in a speech last year. “Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate?” Well, Evans said, the same goes for unemployment. That wouldn’t be a blazing insight to most people, but apparently it was to the Fed.

That’s true, though as I’ve documented elsewhere, the job market was far too slack for decades before the Great Recession, and the consequences in terms of reduced bargaining power have been steep for working families. That’s also one of the reasons inequality has grown. But Tim’s point is still well-taken—it’s one thing to ignore labor market slack—in Fed speak, to weight inflationary pressures over unemployment ones—when there’s an expansion afoot, even if it’s weak. It’s a lot harder when you’re stuck in a prolonged slog.

The personnel point provides another interesting dimension to all this. Members of the Fed board like Evans, Yellin, Bernanke and others seem to genuinely care about the human costs of unemployment and their concerns are driving Fed policy. This tells you something important about the “science” of economics. One would imagine that personal sensibilities don’t influence results in hard sciences–I wouldn’t imagine you’d decode genomes differently depending on how much you care about the struggles of your fellow men and women.

Finally, there’s interesting new research confirming the Fed’s increased emphasis on the unemployment side of their dual mandate (prices/jobs). The figure below, from GS researchers, is the result of a bunch of econometrics (and a bunch of assumptions, so take it with a grain of salt) to estimate the emphasis that the Fed is putting on the unemployment side of the tradeoff when they set interest rates.

The very end of the figure shows they’ve ratcheted up their responsiveness to high and persistent joblessness to historically very high levels (the λ=1 assumes they’re now equally weighting the social costs of elevated inflation and high unemployment). The figure also revealingly shows that the Fed down-weighted unemployment in the 1980s, a period when a weak job market began to erode the bargaining power and wage rates of middle and low-wage workers, heralding the ongoing era of inequality growth that persists today.

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10 comments in reply to "Why is the Federal Reserve the Only Game in Town Trying to do Something About Unemployment?"

The GOP either has a genuine belief in the virtues of austerity or wants to block everything Obama proposes. Given their “deficits don’t matter” voting record during GOP administrations, I’d guess the later. This greatly diminishes the chances of anything meaningful being done about jobs.

Obama has adopted the belt-tightening framing and is not willing to fight for job creating stimulus.

The public has never really supported Keynesian economics. Deficit scolds are well funded and have access to the media.

The Fed is relatively immune to politics and is run by people who are at least familiar with economics. They view their inflation mandate as their primary mission, but are not blind and stupid.

BTW, I’m not disagreeing with your statement about the money in politics and wealth concentration. Political science research shows the government is responsive to the the highest income groups and essentially ignores everyone else, at least when not close to elections, with rare exceptions. Reasons include money in politics, that politicians are in a cocoon in which they don’t see anyone else (in person or on corporate media), the decline in unions (reducing the political strength of workers), etc., etc.

“Trying to do Something” is an apt description. They are probably taking a “cliff” with the medium-term consequences.

When in Philadelphia in September 2012, we visited Independence Hall and attended a briefing there on the Constitution etc. I asked the presenter whether America’s system of government continued to serve the people. He said he believed so and he believed the gridlock will be dealt with post-election. We’ll see.

foosian: “Obama has adopted the belt-tightening framing and is not willing to fight for job creating stimulus.” I believe he believed in it all along, and that’s one reason the stimulus request was so small (several other reasons as well).

I believe he truly believes earned benefit programs MUST be cut, and that’s why he keeps making the attempt. Today I see that Steny Hoyer is trying to get Boehner to try to sway enough Republicans to vote just for this part of the betrayal and he will provide enough Democrat votes to pass the monstrosity in the House. I would hope he couldn’t get enough Democrat votes, no matter now many Republicans switched over, but to me this is an indication of just how insane the Democratic leadership has become on this topic. Social Security does not contribute one cent to the deficit, so cutting Social Security (now through the chained CPI) will not help reduce the deficit, but they are rabid to do it. Why? We have learned that President Obama is mesmerised by Pete Peterson; are the other Democrats as well?

Evans referenced Woodford and Krugman. The idea that the Fed could do more has been discussed and debated among economists and in the blogosphere for a while now. People kept pointing to what Professor Bernanke said about Japan. I like to think the econoblogosphere helped to an extent to create an atmosphere where Evans could push the focus on unemployment. Good job Internet if true.

This year a weird meme caught on with the youth of America: YOLO (you only live once.) As Keynes said in the long term we’re all dead. The half glass full point is that at least someone is focused on unemployment and growth. Will be interesting to see what happens in the UK and Japan. Happy holidays.

“Members of the Fed board like Evans, Yellin, Bernanke and others seem to genuinely care about the human costs of unemployment and their concerns are driving Fed policy. This tells you something important about the “science” of economics. One would imagine that personal sensibilities don’t influence results in hard sciences–I wouldn’t imagine you’d decode genomes differently depending on how much you care about the struggles of your fellow men and women.”

Actually, economics and science should think the same way. Our understanding of biology and physics must be independent of “how much you care about the struggles of your fellow men and women.” But what we choose to do about it is not independent. (We use our understanding to make cars, buildings, aircraft safer, and to fight disease.)

Likewise the understanding of how economies actually behave must not be influenced by “how much you care about the struggles of your fellow men and women.” But what we do about it should be.

Many economists do not like to discuss this honestly because to do so would require admitting that the rush to globalization was a disaster for US workers. It would also require admitting Bill Clinton and Robert Rubin are not the end all and be all of public policy.